You got that shiny new credit card – your first one ever and you’re really excited to make spends on it and maximize on that amazing cash-back / rewards. Chances are you’re going to use it incorrectly and even though you know you’re paying it off on time, you could potentially be sabotaging your own credit score.
Let me explain
Let’s say your first and very first card was the discover card. If you’ve had no previous borrowing record of any kind in the United States you hold what credit companies call a thin file. So to start you off, Discover or any other provider of the credit card will give you a small credit allowance or limit of say $1000 (simplifying for understanding).
They set this limit because worst case scenario, you run with the money – $1,000 is but a minor loss to the bank compared to giving you access to $10,000 right off the bat.
Utilization rate is the rate at which you spend your money. Meaning – Total expenses divided by total credit limit. Credit rating agencies set the cut-off at 30% utilization rate. So, $300 spent out of $1000 reaches that limit.
You can still spend over $300 but now you start spending more than that 30% and that is not good for your account/score. Rating agencies give you a lower score based on your spending – which is now very high. If you pay off all balances, you can actually spend more than the $1000 limit and then your utilization rate will go over 100%.
But why is it bad if I’m paying it off?
As mentioned earlier, you’re spending is significantly higher than the pre determined 30% rate and even though you pay it off, your score will either stagnate or decrease. If you’re regular in payments and are a good borrower in the eyes of the bank, they will eventually start increasing your credit line limit – or you could call them and answer a few financial questions to achieve the same result (they may not always increase your limit).
Calling and asking for an increase in your credit limit can involve a hard pull off your financial record and could reduce your score too (as the number of inquiries made on your account are also a factor towards your credit score).
So what do I do?
Try your best to stay under the utilization rate of the card. If the card has a minimum spend criteria, the bank will automatically give you a credit limit high enough such that you can meet the requirements while staying under that 30% cut-off.
If you have a big purchase coming up, say $1700 flight tickets and your limit is still $1000, call your bank and inform them – they’ll make the appropriate adjustments to suit the transaction (and may require additional details from you).
So get more cards or just increase my existing credit limit?
Once you’ve held your current card for over 6 months, instead of asking for a limit increase (which would involve a hard pull), I’d recommend planning which card to get next to add to your roster such that you may derive additional benefits out of them as that hard-pull is better utilized here.
Planning is key and as is, your credit line limit will increase over time – if you are a good borrower.
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Good second cards to consider –
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